India Should Be Wary Of Cheap Loans From China

With over $3.2 trillion in foreign currency reserves, China has a lot to invest. In addition to investing across asset classes, offering attractive loans has been a growing part of China’s geo-economic strategy. BRIC nations, along with South Africa, are currently gearing up to sign a memorandum of understanding to receive renminbi loans from the China Development Bank. Before they meet in New Delhi on March 29 at the 2012 BRICS summit, it’s important to remember that China’s loans come with strings attached.

India has much to consider. Recently, China made news by lending money to Anil Ambani’s Reliance Communications, for the second time. The Reserve Bank of India last month approved a refinancing of foreign currency convertible bonds worth $1.18 billion dollars by a consortium of Chinese banks for the prominent Indian industrialist. It was the largest refinancing of its kind for an Indian company. The seven-year loan was offered at a 5% interest rate. In 2011, Ambani also needed cash – $1.9 billion – to help finance his 3G telecommunications infrastructure for Reliance Communications. Recorded as the largest financing in the history of India’s telecom sector, the loan was underwritten by the China Development Bank. Reliance said the average projected interest cost savings on the loan are valued at $100 million a year.

While India’s mega-companies are only experiencing the beginning of Beijing’s accommodating bank policy, Brazil and Russia seem to have grown accustomed to taking Chinese money with conditions.

In 2009, Russian oil and pipeline giants, Rosneft and Transeft, took a combined loan of $25 billion from the China Development Bank. The loan was needed to finance a massive project that would supply China 15 million tons of oil a year, or 300,000 barrels a day, over 20 years. Today, Rosneft is paying about 4% in interest, based on a margin of 3.25% over a six month averaged LIBOR rate. With LIBOR at historic lows, the terms of the loan agreement remain attractive for Russian companies.

The pipeline was completed on January 1, 2011, but the cost per barrel has been under dispute between the two countries. Last month, Rosneft approved changes in the existing agreement that permitted a $1.50/barrel discount on crude shipments offered to China National Petroleum Corp, the beneficiary of the supply contract. The Russians will absorb a discount of $3 billion in aggregate revenue over the course of 20 years, or $450,000 a day. The initial capital investment thus served as a bargaining chip for the Chinese in the boardroom and the Russians folded.

Brazil has gotten burned as well. In 2010, the Brazilian iron ore giant Vale signed a $1.23 billion loan agreement to construct 12 ‘Chinamax’ shipping vessels, each with a 400,000-ton carrying capacity for iron ore. Vale had the ships manufactured in China to create some goodwill, thinking the Chinese would then allow the Brazilian company to ship large quantities of iron ore to Chinese ports in its own vessels. But the plan backfired. On her maiden voyage in June last year, Vale’s first Chinamax vessel was barred from anchoring at Dalian port. Facing a backlash from domestic shipping companies, the Chinese government banned Vale’s ships from any port of entry in China. After months of dispute, particularly from China’s state-owned shipping company COSCO, Beijing allowed the ships to unload ore.

If there’s a lesson here, it may be not to expect the Chinese to make concessions on the deals that they make with BRICS partners. When China finances a pipeline, it may demand a lower price on the oil delivered. If you use Chinese yards to build your ships, it may ban your ships.

All countries practice sharp bargaining. China’s use of power through state-owned companies like COSCO is exactly what India has to watch out for. India has to be especially careful with loan repayment plans that rely on assumed business with China. That interdependency can put companies and their shareholders at risk. India has to also beware of seeking loans at the last minute. Reliance tied up refinancing on its bonds just six weeks before the redemption date. With distressed Kingfisher Air looking for money, one can only hope China doesn’t become the reserve bailout bank for strapped Indian corporates.

As the banker to the emerging world, China has the ability to use cheap loans as leverage. But what China concedes on financing, it can recover on the supply agreement. This quid pro quo then becomes more of an implicit guarantee for favourable supply terms and access to markets. Because of these tacit obligations, India needs to look behind the veil. Brazil, burned by its experience, is now stacking up the bricks with protectionist policy to forestall further influence. While the rate of Chinese investment has been significantly higher in Brazil, the Brazilian government’s new ‘BRIC-laying’ policy may be what Russia and India should be considering as they tap China’s ever-flowing river of money.

NOW WATCH: Money & Markets videos

Want to read a more in-depth view on the trends influencing Australian business and the global economy? BI / Research is designed to help executives and industry leaders understand the major challenges and opportunities for industry, technology, strategy and the economy in the future. Sign up for free at research.businessinsider.com.au.